---Rolls-Royce Struggles To Please--- That aerospace, marine, energy and nuclear power engineering business Rolls-Royce has been forced to warn that it will not return to growth during 2015, having previously believed that it would, is both disappointing and worrying. No real surprise that the shares fell 0ver 8% in early morning trade today. In a statement issued through the London Stock Exchange, Rolls-Royce said that economic conditions had deteriorated and, that in some parts of its business, customers have been delaying order decisions and also cancelling orders. The result is that RR now expects 2015 underlying profits to be flat on revenue that will emerge within a range of either 3% higher or lower. Current FY14 expectations are for flat profits to emerge on revenue hit by a previously announced £500m foreign exchange hit will be in a range 3.5% to 4% lower than that of last year. In the knowledge that a one percent movement in the average US$ rate will affect underlying revenue and profits at RR on an annual basis by £15m and £2.5m respectively and that a one percent movement in the average rate of the Euro will impact on underlying revenue and profits on an annual basis by £40m and £4m respectively, it does not require too much imagination to work out that currencies have been going the wrong way. Hedging provides a certain level of relief, of course if done wisely, but the essential problem will always remain. Damaged by defence spending cuts in the US, UK and Continental Europe and as the half-year statement in July confirmed, a one off product quality charge in the marine business, lower volume, higher restructuring and research and development costs plus expectation that adverse currency momentum is likely to continue, perhaps we should not have been quite so surprised by the profit warning statement today. For now, except in terms of producing even greater efficiency of operation, there seems little that the company can do to reverse the trend, although at least there should be no repeat of one-off marine division cost next year. In looking deeper into Rolls-Royce we still find a very well-constructed diverse engineering group based on a strategy of long-term growth and that, despite the statement put out by the company today, will continue to thrive and prosper. This is after all, a long-lead business and one that has invested in its future. There can be nothing short-term about Rolls-Royce and the future will always be based on pursuance of a long-term strategy of earnings potential. Personally, I have long disliked forward outlook statements made by companies to provide guidance to analysts but have little choice but to except them. Of course, just because the forward strategy is based on long term ideals does not mean that the company can ignore short-term implications. Currency momentum is one such aspect. That RR like others such as Airbus, suffer the ongoing problem that of almost all global aerospace and a large part of defence business activity is priced internationally in dollars means that foreign exchange momentum will always be considered a risk. Investors know that and for the most part they live with it but I dare say that RR management must also learn to be a touch more cautious from now on in its forward looking guidance statements. That is not to suggest that a revenue and profit warning did not exist in the July interim statement, simply that it probably was not cautious enough. More worrying maybe, the indication from RR management that free cash flow will decline to around £350m this year, a figure that is less than half the previous forecast which, if I remember correctly, was roughly similar to the £780m reported in FY13. For all that, RR remains in a very strong financial and operational position, not only as a company but also within the various spheres of industrial engineering activities in which it engages. The forward order book at half-year end stage stood at £70.4bn and which I might add stands roughly £20bn higher than it was during 2007. Net cash at the interim stage was reported to stand at £1.2bn and while we may reasonably anticipate that this position will have deteriorated in the second half, there are absolutely no issues of concern about RR’s balance sheet. Nevertheless, what RR has signalled to shareholders today should be of concern to all of us, as it is yet another signal that all is not well within the global economy. That the company says economic conditions are deteriorating should not be dismissed as merely a signal of RR problems alone. Neither can we afford to ignore RR comments that US and EU trade sanctions placed on Russia are now having a serious adverse impact on all of us and, in this case, leading to order delays and cancellations for RR, particularly within the Nuclear & Energy and Power Systems businesses. That Rolls-Royce will weather this storm should not be in any doubt but, as previously mentioned, I do believe that there are some lessons for RR to learn on messaging. To have told investors only three months ago to expect a significant improvement in profit for the second half driven by higher revenue and cost reduction, looks rather surprising in light of today. Investors may be entitled to feel confused at some of the messaging they have received but at least one thing is certain – the long-term growth outlook based on continuing high levels of investment in research and development, in product and in manufacturing capability is no more in doubt today than it was when the successful strategy that has made Rolls-Royce what it is was put into effect 30 years ago. Neither, further negative currency impact apart, should there be any reason to believe that RR’s huge commercial aerospace activities and market strength that account for over half of group revenue will do anything other than provide further excellent growth. CHW (London) 17 October 2014 Howard Wheeldon FRAeS hwheeldon@wheeldonstrategic Tel: 07710 779785
Posted on: Fri, 17 Oct 2014 13:39:47 +0000
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